Income-oriented portfolios are attractive options for many retired investors. From a psychological standpoint, these portfolios may seem appealing. Income-oriented portfolios offer a simple way to plan, and seem to avoid violating the widely-held belief to never invade principal.
Unfortunately, today’s low interest rate environment has made it hard for investors to prudently follow this path. Many investors are seeking a yield higher than what we’d consider to be ‘responsible.’ Short-term income is being prioritized over long-term growth resulting in investors taking out more money from their portfolios than their portfolios are growing by. Doing this can result in a shrinking account balance and puts both portfolio balances and the ability to generate future income at risk.
Advisors can help their clients take a more responsible approach through 4 considerations:
Investors value yield’s role as a source of ‘income’ in their portfolios, but many feel there is a higher level of safety or a conservative aspect introduced by investment securities that provide a healthy yield. This is often not the case—as with higher yield comes greater risks—including potentially significant downside results.
2. Balance the income needs of today with those of tomorrow
How much income an investor needs is a big decision and can be difficult to determine. It’s made more complicated by the fact that the income has to last for some period of time. And you don’t know how long that is. Only you and your client can determine how much income is likely enough, and how much you can responsibly attempt to generate from a portfolio. When comparing funds and investment ideas, be sure to consider total return and not just current yield.
3. Diversify across multiple sources of income
To help achieve balance between the income needs of today and those of tomorrow, consider a diversified approach across multiple sources of income-producing equity, real asset and fixed income securities. Many higher-yielding securities have investment merit and can be additive to a diversified portfolio. However, as with many things in life, moderation is key. A diversified approach may provide an attractive yield and allow a portfolio to grow – potentially sustaining and even growing income in the future.
4. Adapt to risks and opportunities in the market
The same way today’s investing environment is different from yesterday, tomorrow will be different than today. Be aware of all the risks and potential opportunities in the market and consider an income-oriented investment solution that seeks to proactively and quickly adapt to changes that may arise.
The bottom line
We don’t believe yield should be the singular driver of investment decisions. If your clients are ‘reaching for yield,’ it may be an opportunity for you to steer them towards a more diversified approach that seeks to achieve a ‘responsible’ yield. It’s about balancing the need to generate income today with the need to generate income in the future.
Disclosure: Diversification does not assure a profit and does not protect against loss in declining markets.
Rod Greenshields is a consulting director for Russell Investments’ U.S. private client consulting group. To see this post in its original form, with more information and full disclosures, visit Russell's Helping Advisors blog.